Flowers Joins Ross Rivaling U.K. Banks for Home Loans

J. Christopher Flowers, founder and chairman of J.C. Flowers & Co. LLC who moved to London from the U.S. last year to help oversee the firm’s European assets, invested 65 million pounds in Castle Trust, which opened in October. Photographer: Thomas Lee/Bloomberg

March 8 (Bloomberg) -- U.S. private-equity investors Wilbur
Ross and J. Christopher Flowers, who’ve made billions of dollars
turning around industries from steel mills to Japanese banks,
are lining up to finance British homebuyers as the country’s
biggest banks pull back.

Five years after mortgage lender Northern Rock Plc
collapsed, loan approvals are about half what they were in the
boom decade that ended in 2007 and the government is pressing
for more competition. Even Tesco Plc, the nation’s biggest
retailer, is stepping in to help fill a funding gap spawned by
the global credit crisis and reduced bank lending as the housing
market shows signs of improvement after nine months of declines,
according to Hometrack Ltd. data this week.

“They’re betting the market has bottomed out and there
will be a recovery,” said Ray Boulger, senior technical manager
at mortgage broker John Charcol Ltd. in London.

Flowers’s buyout firm, JC Flowers & Co., set up a lender
offering private-equity-style terms, allowing homeowners to
forgo monthly payments in exchange for sharing the profits when
their home is sold. Ross, who built his fortune buying bankrupt
steel, coal and textile companies, invested 350 million pounds
($526 million) for a 45 percent stake in Richard Branson’s
Virgin Money Ltd.

Both investors’ firms are among bidders for 316 branches
that Royal Bank of Scotland Group Plc is selling as a result of
its government rescue. Bank of England Governor Mervyn King this
week urged the government to split RBS into a so-called good
bank and a bad bank -- the same strategy used with Northern Rock
-- to speed the return of Britain’s biggest publicly owned
lender to private hands after it was bailed out five years ago.

Dominant Lenders

The new competitors are breaking into a mortgage market
that’s been dominated for decades by RBS, Lloyds Banking Group
Plc, Barclays Plc, HSBC Holdings Plc and Santander U.K. Plc,
which was Abbey National Plc until Spain’s Banco Santander SA
purchased it in 2004. The five banks controlled about 62 percent
of the country’s mortgage market in 2011, down from 73 percent
in 2010, according to the latest figures from industry group the
Council of Mortgage Lenders.

“It’s not an easy market to enter, especially if you’re
trying to build big from scratch,” said Stephen Noakes,
commercial director at Lloyds, the country’s biggest mortgage
lender.

Ross, 75, said by e-mail that “in one recent month Virgin
made more than one-third of all the single-family mortgage loans
in the entire U.K. market.”

Oaktree Investments

U.S. buyout firms are playing an increasingly larger role
in the U.K. housing market. Oaktree Capital Group LLC, the Los
Angeles-based investor led by Howard Marks, last month bought
homebuilder Countryside Properties Plc. It already has a stake
in Countrywide Plc, the U.K.’s largest real estate broker, along
with Leon Black’s Apollo Global Management LLC and Alchemy
Partners LLP. Countrywide is currently seeking to raise 200
million pounds in an initial public offering.

Flowers, Ross and others such as Vernon Hill, another
American who three years ago co-founded Metro Bank, the U.K.’s
first new consumer bank in more than a century, see an opening
in the scandals and bad debts that have sullied the reputations
and balance sheets of Britain’s biggest banks.

With the country at risk of slipping into its first triple-dip recession, the government is encouraging new competition as
it tries to help homebuyers by making mortgage money available.

Easing Rules

Chancellor of the Exchequer George Osborne, for instance,
said last month that bank-payment systems will be regulated to
safeguard the interests of new entrants. And the Financial
Services Authority will allow startup banks to open with core
capital equal to 4.5 percent of their assets, about half the
level for bigger banks, FSA Chairman Adair Turner told the
Banking Standards Commission on Feb. 27. Smaller banks had been
required to reserve more capital than larger rivals.

“The government certainly wants more competition,”
Boulger said.

The Treasury also worked with the BOE to start an 80
billion-pound lending program that allows banks to borrow at
cheaper rates for as long as four years.

“Research shows that almost 40 percent of customers would
consider switching to a new entrant,” Virgin Money Chief
Executive Officer Jayne-Anne Gadhia, 51, said by e-mail. “While
some lenders have been shrinking their mortgage books, Virgin
Money has supported the market by growing lending.”

Castle Trust

Flowers, 55, who moved to London from the U.S. last year to
help oversee the firm’s European assets, invested 65 million
pounds in Castle Trust, which opened in October. It’s providing
customers’ financing for home deposits and hedging its bets by
selling bonds linked to a home-price index to retail investors.

Castle Trust lends buyers a portion of their down payment
and helps arrange a mortgage from a traditional lender, such as
Kent Reliance Building Society, in which Flowers bought a stake.
With a Castle Trust shared-equity loan, customers don’t have to
repay until the debt matures or the property is sold; then
Castle Trust takes as much as 40 percent of any profit or shares
20 percent of any loss.

“We’re providing people with a safer way to buy their home
because we’re allowing them to issue equity,” Castle Trust CEO
Sean Oldfield said in an interview. “We share in the profit and
loss.”

The private-equity firm’s U.K. business is led by former
FSA Chairman Callum McCarthy, who headed the regulator when
Northern Rock was nationalized and during the build-up to the
bailouts of RBS and Lloyds. Near the end of his term in 2008, a
parliamentary committee criticized the agency for failures in
supervising Northern Rock, the first U.K. lender to suffer a run
on deposits in more than 140 years.

Seizing Opportunity

Virgin Money’s Gadhia said last year that she saw an
opportunity in Northern Rock. Buying the failed bank would
instantly give Virgin the footprint and product range to vie
with Britain’s biggest retail banks.

Advised by investment bank Greenhill & Co., she put
together a group to bid for the stricken bank. Among those
Greenhill approached was Ross. His private-equity firm, WL Ross
& Co., invested about 350 million pounds to take over
Newcastle-based Northern Rock’s retail operations in a deal that
was completed in January last year.

Gadhia said last month that since Virgin Money and Northern
Rock combined at the start of 2012, new and existing customers
had opened more than 1.2 million new accounts with the bank,
which currently has 75 branches.

Tesco Lending

Other companies are getting into mortgage lending. Tesco,
the U.K.’s largest grocer, began offering mortgages to customers
with a minimum 20 percent deposit in August. Rival retailer
Marks & Spencer Group Plc in June announced a plan to open 50
bank branches in its stores within two years. M&S Money, a joint
venture with HSBC, opened its first bank branch in central
London in July.

Metro Bank, whose co-founder Hill built Commerce Bancorp
Inc. into the largest bank in New Jersey, said in June it had
raised 126 million pounds to expand to 200 branches in greater
London by 2020 from 15 now. New York-based hedge fund Moore
Capital Management LLC purchased a stake in the London-based
bank last year, Sky News reported.

“If you look at the U.K. relative to some other
jurisdictions, it looks more profitable” for mortgage lending,
Lloyds’s Noakes said. That’s because lenders have the ability to
“re-price the back book of customers,” he said, meaning banks
can change rates after a few years depending on loan terms and
market conditions.

Flowers Expands

Seeking to expand their presence, Flowers and Virgin are
among bidders competing for the RBS branches that the Edinburgh-based lender is selling in connection with its government
rescue, two people with knowledge of the process said in
November. Apollo and JC Flowers are forming a joint venture to
bid for the branches, Sky News reported in December.

Private-equity firm AnaCap Financial Partners LLP, which
started Aldermore Bank in 2009, is also bidding for the RBS
sites. The London-based buyout firm last year formed a joint
venture with Blackstone Group LP, the world’s biggest private-equity firm, to seek investments in banking and insurance.

Housing is recovering faster in the U.S. than in the U.K.
With mortgage rates near historic lows, 4.66 million previously
owned houses sold last year in the U.S., the most since 2007,
the National Association of Realtors said last month. Prices
gained 12 percent in January from a year earlier, the biggest
12-month increase since 2005.

Both Hometrack and Halifax, a unit of Lloyds, said this
week that U.K. house prices rose in February, a sign that the
government’s credit-boosting measures are helping. The average
cost of a home increased 0.2 percent from January to 162,638
pounds, the Nationwide Building Society said this month. House-price growth accelerated to 0.6 percent in the three months
through February from 0.4 percent in the previous three months.

Still, the number of loans for home purchase fell 3 percent
in January from a year earlier, the Council of Mortgage Lenders
said in a Feb. 20 statement. Home mortgages totaled about
540,000 last year compared with 1.01 million in 2007, according
to the CML.

“There’s clearly plenty of scope to increase mortgage
lending,” Boulger of John Charcol said. “There are plenty of
signs we’ve come through the worst of it. It’s just a question
of how long it takes to see the recovery.”